MULTINATIONAL COMPANIES NEED TO
PLAN for issues involving identification,
use, reporting and valuation of their intellectual
property (IP) in order to avoid misdirecting
internal investments or depriving their
international business units of the use of such
intangible assets.

CPAs CAN ASSIST BUSINESSES
in planning IP strategies by using a
four-step process: Identify IP and demonstrate how
effectively managing it can help a company achieve
strategic business objectives, develop
alternatives for structuring business functions
and risks, develop a strategy for aligning risks
and functions with ownership of IP within the
company, and implement and monitor the strategy to
ensure the company gets maximum return on its IP.

FINANCIAL MANAGERS NEED TO
IDENTIFY I P issues that could lead to
international business problems and help uncover
opportunities for improvement, such as
undocumented IP ownership, gaps in legal
protection, an inefficient entity structure, low
return on investment in IP development, high
transaction costs and customs duties and
unpredictable profitability in multiple
jurisdictions.

CPAs SHOULD WORK CLOSELY WITH
OPERATIONS and treasury personnel to
continuously monitor the IP plan and validate the
strategy by examining monthly management reports,
reviewing quarterly financial data and
periodically assessing the tax and financial
statement impact of business transactions.

COMPANIES CONTINUOUSLY FACE
LIFE-CYCLE EVENTS that reshape plans to
develop and maximize the value of specific assets.
When a company begins an R&D project, CPAs
should perform a cost-sharing analysis to decide
whether multiple business units should fund the
costs of development and, as a result, own rights
to use the ensuing IP.

MICHAEL W. HARDGROVE, CPA, JD, is a
partner at PricewaterhouseCoopers. Based in Boston,
he is the firm’s national leader for global
structure alignment, which deals with international
business transition and intangible asset strategies.
His e-mail address is
michael.w.hardgrove@us.pwcglobal.com . ALEX
VOLOSHKO, CPA, is a manager in the global
structuring practice also at PricewaterhouseCoopers
in Boston. His e-mail address is alex.voloshko@us.pwcglobal.com
.

s companies seek earnings growth and sources
of investment capital, it becomes critical for them to
manage resources more productively. In today’s global
economy, many enterprises rely extensively on developing and
effectively exploiting their intellectual property (IP) to
enhance the bottom line. For companies with customers,
suppliers or business activities in multiple countries,
managing such intangible assets can be extremely
complicated. CPAs, as financial managers or advisers, can
help their employers or clients develop a strategy that
tackles many complex international business issues,
including cash management, resource allocation,
administrative simplification and cost containment. This
article discusses how CPAs can help their clients treat IP
as the economic cornerstone of a sound business strategy
while avoiding some all-too-common pitfalls along the way.

WATCH OUT FOR PITFALLS CPAs can identify IP activities that create financial
value as well as develop strategies to use, value and report
on intangibles. Companies that do not have such strategies
run the risk of either mismanaging their IP investments or
not fully capitalizing on them. For example, a company might
be legally or contractually prohibited from transferring an
important technology to a foreign business unit that could
otherwise benefit from it. Furthermore, if management does
not identify internally developed or enhanced IP, such as
processes, unpatented know-how or marketing intangibles, it
could jeopardize the legal protection of such assets. This
can be especially true in foreign countries where local laws
may not protect unregistered rights as they do in the United
States. As a result, operating expenses, taxes, cash flows
and profits of a company’s global business units could be
adversely affected.

Consider a hypothetical company, AB-Tech,
which develops and distributes technology solutions
to clients worldwide. Its business model combines
services, hardware and software in comprehensive
solution packages. In its early stages AB-Tech had a
relatively simple business structure. Its U.S.
operations served as headquarters and performed all
distribution, research and development and
marketing. AB-Tech’s structure became increasingly
complex as it expanded into markets in other
countries.

CPAs, as financial
managers or advisers, can help their
employers or clients develop a strategy
that tackles many complex international
business issues, including cash
management, resource allocation,
administrative simplification and cost
containment.

For example, AB-Tech established a subsidiary for
technology development and marketing in France. The French
operation not only generated enhancements to the technology
but also created a substantial customer base throughout
Europe. In focusing on rapid market expansion in the United
States, company management had little time for strategic
planning for its European operations, let alone the
potential growth in IP value.

CAs a result AB-Tech
managers treated U.S. R&D as the company’s only
source of IP and did not consider that the contracts
and activities of the French subsidiary also
contributed to the corporate IP portfolio. This
misunderstanding caused several problems. First,
AB-Tech did not register the technology enhancements
it had developed in France, nor did it take measures
to protect the subsidiary’s marketing rights and
customer lists. Consequently these assets were at
risk of “theft” from competitors or its own
enterprising employees. Second, U.S. operations
managers did not internalize any of the French
unit’s processes (for example, systems improvements
and marketing knowledge) that could have benefited
the entire organization. Because AB-Tech’s U.S.
managers didn’t know about or use these intangible
assets, the company couldn’t effectively leverage
them or report their value to banks, investors or
customers. The company’s poor handling of its IP
created problems that could have been avoided—such
as lost efficiencies resulting in a higher cost of
products delivered to customers and the replication
of certain R&D activities by the parent, as well
as exposure to French income taxes on profits
attributable to the IP the subsidiary developed.

A BETTER STRATEGY
CPAs have many of the skills
and expertise needed to advise clients on how to create a
business structure that optimizes IP. “CPAs, in their
capacity as financial and business advisers, are the logical
choice to assist companies in identifying and developing
long-term, value-creating IP strategies,” says CPA Michelle
Fugawa, an attorney and senior director of worldwide tax at
Ingram Micro Inc. in Santa Ana, California. “They are
familiar with accounting systems, technical rules and
expectations of capital markets.”

If CPAs had worked with
AB-Tech management to review strategic objectives
and craft a proactive global IP plan, they could
have enabled the company to identify value-creating
business functions and likely sources of IP; a
flexible structure for future acquisitions or
development; techniques for dealing with
international growth issues, such as subsidiary
formation, branch offices and foreign licensing; an
awareness of necessary legal protections in
international markets; and a system to make foreign
partnerships, such as joint ventures and licensing
agreements, more flexible and lucrative.

CPAs
can help businesses achieve a proactive IP
strategy by using this four-step process:

Identify IP and demonstrate how
managing it effectively can help a company achieve
its strategic business objectives.

Develop alternatives for structuring
business functions and risks.

Develop strategy for aligning risks
and functions with ownership of IP within the
company.

Implement and monitor the business’s
global IP strategy.

Exhibit
1: Measuring Costs and
Benefits of IP Planning

Net
present values (NPV) of
projected IP planning costs:

Employee costs

$100,000

Professional fees (legal,
accounting, tax advice)

150,000

Operational costs

250,000

Total projected
investment

$500,000

Expected benefits of the IP
strategy: Reduced costs of
borrowing

$250,000

Elimination of
duplicate functions

750,000

Reduced costs of gathering
and reporting data

200,000

Reduced costs of corporate
maintenance

350,000

Reduced taxes
and transaction costs

450,000

Total expected benefits
of IP planning

$2,000,000

Step 1: Identify IP and demonstrate how managing
it effectively can help a company achieve its strategic
business objectives. By addressing IP
management issues, CPAs and financial managers can help
companies avoid limitations to international business growth
while uncovering opportunities for improvement. For example,
an IP review can identify undocumented IP ownership, gaps in
legal protection, an inefficient entity structure, low
return on investment in IP development, high transaction
costs, value-added taxes or customs duties and unpredictable
profitability in multiple jurisdictions. (For a cost/benefit
breakout of IP planning, see exhibit 1 , above.)

CPAs can begin the planning process by determining
which intangible value drivers, or operational resources,
account for the success of a particular product or service.
By interviewing company employees (for example, R&D
engineers, supply chain managers and marketing and
distribution personnel), CPAs can analyze each business
function in order to understand how it contributes to
generating intangible assets. Gathering such information is
often referred to as a “functional analysis.”

In
such an analysis CPAs can not only identify registered IP
but also ask managers which of their business unit
activities result in value-creating expenditures, such as
R&D, marketing and customer service. In public remarks,
Joseph Ripp, CPA, vice-chairman of America Online Inc.,
recommended that financial managers break down IP by line of
business and perform frequent updates via feedback from the
company’s operating units. This process can be instrumental
in creating an IP inventory. For each significant intangible
asset, companies should determine the metrics, such as
revenue per customer or annual cost savings, that measure
its success in maximizing its value. Financial managers
should use these metrics to make business decisions—for
example, how best to expand the customer base or whether to
develop IP internally or acquire it.

By performing a
functional analysis, AB-Tech’s accountants would have
learned that both the successful product design and the
company’s growing trade reputation in France had created
valuable marketing IP. With this knowledge and an IP
inventory, management then could have decided how to use it
effectively throughout the entire organization.

Step 2: Develop alternatives for structuring
business functions and risks. Armed with
the results of a “functional analysis,” CPAs should evaluate
the company’s business units in the context of “profit
centers” and “cost centers.” Cost centers typically do not
own value-creating assets; they bear limited commercial risk
and can act as group service providers. Economists often
refer to such services as “routine” because these services
do not, by themselves, create value. A cost center with
limited IP or risk, and performing administrative,
distribution or procurement functions, is often referred to
as a shared services center. Such centers allow the company
to reduce transaction costs and respond to financial and
operational challenges faster and more efficiently.

Financial managers can use shared services centers not
only to reduce redundant costs by pooling resources and
standardizing processes such as invoicing, data processing
and cash collection, but also to design transaction flows
with customers and between business units that will support
the global IP strategy. In those cases earnings are
attributable to factors such as assuming business risks,
owning technology and funding expenditures and may be
considered “premium” or value-creating. Therefore, if the
shared services center enters into the transaction flows and
retains the economic rights to developing IP, it can become
a profit center. In international business, such operations
(especially when housed in a separate subsidiary) are often
referred to as a “principal company.”

Step 3: Develop a strategy for aligning risks and
functions with ownership of IP within the company.
CPAs can recommend spreading development
expenses among business units as a strategy for sharing
risk. If a multinational organization expects significant
economic benefits from its IP, sharing development costs can
ensure that all business units that are parties to the
arrangement will benefit from and have rights to the
resulting IP. At a 2002 conference, David Roth, CPA and
international tax manager at General Motors Corp., said his
company began using global cost-sharing agreements many
years ago as a worldwide IP management tool to help strike a
balance between the need for centralized control over
emerging automobile technology developed and used in
multiple locations and the company’s move to decentralized
management. In addition cost sharing gave GM business units
access to the entire IP portfolio while helping them reduce
and maintain centralized IP funding and legal ownership.

In the hypothetical example, AB-Tech’s CPA advisers
could have encouraged the company management to establish a
profit center (or principal company) with sufficient
financial and managerial resources to develop, own and use
IP of value in a geographic region or market segment.
AB-Tech’s global units could have used the principal
company, along with cost sharing, to codevelop and co-own
European IP rights to reduce the risk of a dispute between
the IRS and French tax authorities over IP ownership. For
example, U.S.-based AB-Tech and a European principal company
could have proportionately funded global R&D and
marketing costs, and both entities would have co-owned a
global intellectual property.

The IRS has accepted
cost sharing as a global business technique provided the
taxpayer follows the regulations governing qualified
cost-sharing arrangements. Outside the United States, the
Organisation for Economic Co-operation and Development (a
group of 30 countries that interprets emerging economic and
social issues and identifies common policies, www.oecd.org ) also has
approved the cost-sharing concept and established its own
cost-contribution-arrangement guidelines.

A caveat. The IRS has recognized the importance of
IP to international business, and the use of common
techniques such as cost sharing, in IRC section 482.
However, many provisions of the current tax law preclude
companies from entering into tax-motivated transactions, and
recent IRS initiatives are aimed at further tightening the
rules on disclosure and compliance.

For example, in
her testimony before the House Ways and Means Committee on
June 6, 2002, Pamela Olson, as acting assistant secretary
for tax policy of the U.S. Treasury, pointed out the
potential for abuse where IP or other assets are transferred
between related parties at less than arm’s length. Olson
announced that the Treasury would undertake a comprehensive
study focusing on the tools needed to ensure that
cross-border transfers and other related-party transactions,
particularly transfers of IP, could not be used to shift
income outside the United States. This could include a
review and possibly revisions of the documentation and
penalty rules and of the substantive rules relating to IP
transfers and the use of cost-sharing arrangements in order
to ensure that current transfer pricing rules could not be
used to facilitate the transfer of IP outside the United
States for less than arm’s-length consideration.

Step 4: Implement and monitor the business’s
global IP strategy. CPAs should design
business structures to be flexible enough to help managers
deal effectively with changes in circumstances. In AB-Tech’s
case, the CPAs can guide management through financial,
accounting and tax issues to transfer European distribution
and cash management functions to the principal company. When
CPAs draft such a global plan, they should carefully
document the international strategy in a report, discuss
alternative scenarios with operations management and review
and coordinate issues with legal counsel and other experts
in foreign jurisdictions.

Management and CPAs
together should undertake the implementation steps of the
international IP planning process. Included in this phase
would be the preparation of income statements and balance
sheets and monitoring the effects of any changes in
operations. Traditional annual assessments might not be
sufficient, particularly in volatile areas of the world.
Instead, the CPAs should work closely with operations and
treasury personnel to continuously monitor the strategy by
examining monthly management reports, reviewing quarterly
financial data and periodically assessing the tax and
financial statement impact of business transactions.

Such analyses enable financial advisers to examine how a
company complies with local accounting rules, manages costs
of intercompany transactions, evaluates foreign exchange
exposures and reviews tax-return-filing positions. In
addition, when CPAs help management create and implement an
efficient structure for a business, planning opportunities
may follow. For instance, when an organization establishes
an international principal company, it can change
transaction flows or structure the ownership of subsidiaries
to benefit from treaties between countries and reduce its
cost of cash flow.

ALIGN PROCESS WITH LIFE CYCLE
Strategic objectives alone do
not drive the IP planning process—companies continuously
face events that reshape their plans for developing and
maximizing the value of specific assets. As a company grows
and matures, it must make decisions about R&D efforts,
obtaining financing, enlarging the revenue base for new
products and services or geographic expansion. As a business
matures, the costs and complexity of implementing many of
its decisions often grow exponentially. But a company can
find it relatively inexpensive to achieve financial and
international tax benefits if it proactively structures IP
rights and business functions and risks in conjunction with
the major events in its life cycle. (For an example of a
company’s life cycle, see exhibit 2 .)

Exhibit 2: Company Life
Cycle

IP planning is essential in another life-cycle event—a
merger or acquisition. Provisions of FASB Statement no. 142,
Goodwill and Other Intangible Assets, encourage
companies to inventory their IP rights during an acquisition
and treat them as “strategic assets.” (For more information
see “ FASB Changes Accounting for IP, ”
and “ A
New Scorecard for Intellectual Property, ” JofA
, Apr.02, page 75.)

Efficient corporate
planning and cost sharing can ensure that IP creation
enhances the business’s objectives and helps it avoid having
to relocate or restructure its IP-generating functions
(R&D, marketing, customer service and procurement). For
example, if AB-Tech had had a better IP plan, it could have
facilitated sharing of global IP by its American and French
operations and invested in technology more effectively.

TAKE A BEST-IN-CLASS APPROACH
As more American companies
venture into the global marketplace and establish business
units in various foreign countries, CPA advisers can help
them develop IP strategies that deal with international
business issues and avoid pitfalls. It is essential for
companies relying on intangible assets to have business
structures that protect them among their global units while
minimizing the risks and costs of doing business
internationally. With an appropriate plan in place,
organizations can arrange transactions to reduce the costs
and risks, better manage their aftertax cash flows,
facilitate joint ventures and acquisitions and monitor their
processes to maximize profits.

FASB Changes Accounting for IP
The Financial Accounting Standards
Board amended in 2001 its standards on the
pooling-of-interests accounting method for business
combinations and goodwill amortization, issuing
Statement no. 141, Accounting for Business
Combinations, and Statement no. 142,
Goodwill and Intangible Assets. Companies
no longer can combine goodwill with intangible
assets on their balance sheets. They must report
goodwill and intangibles separately, disclose asset
classes such as patents and trademarks and provide
the estimated useful lives of intangible assets in
financial statement footnotes. FASB specifically
identified patents, trademarks, trade secrets,
licensing agreements and other intellectual property
involved in a business combination as intangible
assets that require a separate valuation from
goodwill. For more information see www.fasb.org and “
Say
Good-Bye to Pooling and Goodwill Amortization,
” JofA , Sep.01, page 31).